Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Wai Chi Holdings (HKG:1305), it didn't seem to tick all of these boxes.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Wai Chi Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.042 = HK$33m ÷ (HK$2.0b - HK$1.2b) (Based on the trailing twelve months to December 2020).
Thus, Wai Chi Holdings has an ROCE of 4.2%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 8.5%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Wai Chi Holdings' ROCE against it's prior returns. If you're interested in investigating Wai Chi Holdings' past further, check out this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
On the surface, the trend of ROCE at Wai Chi Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 4.2% from 6.1% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
Another thing to note, Wai Chi Holdings has a high ratio of current liabilities to total assets of 61%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Bottom Line
From the above analysis, we find it rather worrisome that returns on capital and sales for Wai Chi Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last five years have experienced a 68% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
Wai Chi Holdings does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is significant...
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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Wai Chi Holdings
Wai Chi Holdings Company Limited, an investment holding company, manufactures and trades in light-emitting diode (LED) backlight and LED lighting products to business corporations and public utilities in the People’s Republic of China, Hong Kong, Taiwan, and internationally.
Excellent balance sheet with solid track record.